As a complex financial instrument, cryptocurrency derivatives are favored by high-risk appetite investors due to their leverage and uncertainty. Independent of the spot trading market, they continue to generate fee income for platforms and have become one of the standard businesses for cryptocurrency exchanges in recent years.
However, the high leverage ratio, deposit and withdrawal settlement services, and even price manipulation of various exchanges have brought more legal risks to cryptocurrency derivative trading, which is already operating in a legal gray area. As early as last year, there was a precedent for penalizing key personnel of certain exchanges with the crime of “operating a gambling den”. The core of being recognized as “operating a gambling den” is the high leverage contract section of the exchange. It is understood that a large proportion of the cryptocurrency exchanges that have recently been subject to enforced measures and shutdowns by the police are suspected of operating a gambling den due to irregular operations in the contract section.
Currently, the regulation of cryptocurrencies both domestically and internationally is still in its early stages, and relevant laws and regulations are not yet perfect, which has led to differences in judicial practices in different regions. This article will analyze and sort out the legal risks that may exist in the contract business of exchanges and the responsibilities faced by staff members.
Risk factors of gambling involvement in the contract business of trading platforms
The essence of cryptocurrency derivative business is the imitation of the modern financial futures market model, which also uses standardized contracts and margin systems. The only difference is that the underlying asset is replaced with cryptocurrencies. The profits of participants are related to the fluctuation of the market, and it does not belong to a gambling model. However, due to the lack of corresponding regulations, cryptocurrency exchanges’ contracts often have scenes that do not exist in traditional financial markets, such as high leverage and artificial manipulation. Additionally, platforms introduce OTC trading to provide fiat-to-cryptocurrency exchange services, thereby forming a closed loop for fiat deposit and withdrawal.
Therefore, there have been many cases in judicial practice where cryptocurrency trading platforms have been identified as operating a gambling den due to their cryptocurrency derivative trading businesses. The analysis of the core elements is as follows:
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1. High leverage
Although cryptocurrency derivatives adopt the same trading rules as traditional financial futures products, the high-risk and unregulated contract products break through the safety boundaries. Currently, derivative trading markets of various trading platforms generally allow users to engage in extremely high leverage trading. For example, some trading platforms offer contract trading functions with leverage as high as 125x or even 500x. This means that in extreme cases, even slight fluctuations in asset prices can lead to forced liquidation and loss of all margin for users.
And this situation completely lacks predictability. The profit and loss of users are greatly affected by high leverage, far more than the impact of the fluctuation of the intrinsic value of assets. Such high-risk derivative businesses may be suspected of opening a casino crime.
According to (2022) Ji 06 Xing Zhong 33 Hao, Zhou Yan, Jiang Xiaojian, and others are guilty of opening a casino crime. Because they promoted and provided a trading platform for default 50x leverage contracts, acted as agents and collected bets, the behavior of the sixteen defendants constituted the crime of opening a casino.
And in some cryptocurrency trading platforms that have stopped operating due to force majeure, the maximum leverage ratio of their contract business is between 100x-500x, far exceeding the multiple of the platforms involved in this case. We also observed that the leverage ratio of the mainstream cryptocurrency trading platforms in the industry is constantly increasing and almost all are above 100 times.
2. Price manipulation
In the early stage of the cryptocurrency industry, there was a phenomenon of cryptocurrency exchanges adding liquidity to the trading market by controlling the trend in the background and involving market makers in order to attract users. However, whether it is controlling the trend in the background or the platform personally participating in market making, it means that the user’s trading counterparty is the platform, and the real objective price disappears, and the speculative nature of contract trading no longer exists. The platform may be suspected of fraud or even opening a casino crime.
In fact, even Binance was previously accused by the SEC of manipulating trades. The lawsuit documents revealed that the actual controller of Sigma Chain, the main market maker of Binance Exchange, is Zhao Changpeng. After the launch of Binance.US platform, Sigma Chain has been the trading counterparty of Binance.US platform clients, and sometimes even the only counterparty.
In traditional casino cases, according to (2018) Yue 1881 Xing Chu 140 Hao, Nie Mou, Sun Mouyuan’s first instance criminal judgment for opening a casino. Because they acted as agents for gambling games, manipulated and changed the gambling odds, and profited from it, thirteen defendants were found guilty of opening a casino crime.
With the increase in the understanding of cryptocurrencies by the judiciary, similar behaviors of illegally profiting from manipulating cryptocurrency prices may also generate criminal risks related to gambling.
3. Providing fiat currency deposit and withdrawal channels
Although online entertainment betting and online gambling have similar forms, there are essential differences, that is, whether entertainment chips are allowed to be freely exchanged with cash. If platform operators or agents allow free exchange between entertainment chips and real currency, they may be suspected of opening a casino crime. Looking back at our judicial practice, it is not difficult to find numerous real cases.
According to (2020) Ji08XingChu38, the first-instance criminal judgment of Xiao Zhijian and Xiao Le Ming for the crime of operating a gambling den, the court believes that the defendants knowingly engaged in the buying and selling of game coins, even though it is not allowed, for the purpose of making profits and providing assistance to gambling activities, thus constituting the crime of operating a gambling den.
Similarly, according to the “Notice on Preventing Bitcoin Risks,” “Announcement on Preventing Risks of Token Issuance and Financing,” “Notice on Further Preventing and Dealing with Risks of Virtual Currency Trading Speculation,” and other documents, although China essentially denies the legal status of cryptocurrencies, it does not deny the commercial nature of individual transactions. This means that the acceptors who provide cryptocurrency acceptance services for exchanges operating illegal contract trading, as well as the staff of the platform’s OTC department, objectively help the platform establish a fiat currency deposit and withdrawal channel, and may be suspected of operating a gambling den.
Cryptocurrency Trading Platforms from the Perspective of Online Gambling Platform Operators
Re-examining cryptocurrency trading platforms within the existing legal framework in China, if the cryptocurrency derivative services provided by the platform are suspected of operating a gambling den, then the following types of employees on the platform may be affected:
Head of the contract trading department: responsible for the actual operation of the online gambling platform/product, and therefore highly likely to be considered the principal offender;
Contract trading operation personnel: participate in the operation of the online gambling platform, attract users to the platform through advertising, channel cooperation, etc.
OTC staff and acceptor service providers: provide acceptance services for users including gamblers, objectively helping the online gambling platform achieve fund settlement functionality;
KOLs who attract users to the platform: develop downlines, earn commissions through hierarchical referrals, etc., which is one of the monetization channels for some KOLs in the cryptocurrency field. However, whether it is attracting users to the gambling den or profiting from customer losses, both will face legal risks;
Platform technical personnel: provide internet access, server hosting, network storage space, communication transmission channels, software development, technical support, and other services;
Platform shareholders: participate in the platform’s profit sharing.
With the increase of related cases, this fact may have a widespread psychological impact on industry practitioners. As a platform operator, it is necessary to be more cautious in dealing with the contract trading department in order to avoid potential risks to the normal operation of the platform.
For major cryptocurrency trading platforms, Bitrace suggests:
1. Do not launch contract products with high leverage ratios and implement user segmentation to limit the leverage ratio available to non-professional investors, in order to avoid users incurring unbearable asset losses;
2. Comply with the laws and regulations of the jurisdiction where the business is conducted, and prevent providing related services to users in areas subject to policy supervision through IP isolation, KYC, and other means;
3. Exercise caution in conducting OTC business. On one hand, require OTC merchants to strengthen KYB authentication and recommend that they purchase corresponding KYT/AML services. On the other hand, the OTC business department of the platform needs to comply with the laws and regulations of various countries and avoid providing related services to users in prohibited areas.
As for industry practitioners, they should further enhance their legal awareness and fully understand the compliance of the platform before joining. They should avoid having a mentality of luck or stepping on the legal red line for short-term benefits.